Buying foreclosures makes lots of sense

Armen Hareyan's picture

Here is a simple foreclosure investment rule of thumb. While it’s certainly possible to make money flipping foreclosures, it takes time, effort, and on many occasions, a good deal of rehab work. Selling them quickly often requires the services of a real estate agent. But, to cite a cliché, it’s not rocket science.

That is why a story in the Star Ledger about a woman who bilked several real estate investors out of $1.2 million was such a surprise to me. It was not the fact that she swindled them that was a shock. After all, that kind of scheme occurs every day.

The surprise was that she was unable bring back a return to the investors. She proposed to return their original investment in these foreclosures, plus 70% of the profits, while she would take 30% of the profits as a commission. What she proposed was not at all unreasonable. Please note that she did not offer them a 70% return on their funds, just 70% of the profits. Had I been one of her investors, I would have been pleased with this type of return. As the news reported, the plan did not unfold as originally stated. Instead, the woman was arrested and the investors lost a great deal of money.

However, had she been honest and known the typical costs of buying and reselling foreclosures, this is how the scenario might have unfolded.

An easy way to approach foreclosure investing is to work using the concept of one dollar (100 cents) as the retail cost of a property when it is in good condition. Foreclosures in today’s market are typically sold at 35 – 40 cents on the dollar (35-40% of value). All of these homes have been neglected and abandoned for at least 6 months. By the way, all of these properties, without exception, are bought for cash. No loans allowed.

Now that you have purchased these foreclosure properties, you are planning to resell this property to someone else and make a profit. So you put the property on the market, figuring it’s still cheap enough that someone will want to buy it and fix it up. You will probably use a realtor, and pay a 6% commission in order to expedite your sales.

Much to your dismay, you discover that new home buyers can’t purchase this foreclosure because they won’t be able to get a loan for a property that needs so much fixing up. But someone has to spend time and money to get this work done, otherwise the house can’t be lived in.

So you sell to another group of investors who can buy from you for cash and who are willing to spend the money to perform the work necessary to make the property habitable. And now that they’re fixed up, these homes can be resold to home buyers who will purchase using mortgages. Naturally, this second group also expects to make a profit

You sold to the investors for 53 cents, minus the 6 cent commission you paid to the realtors. You’ve made 10 cents on each house, a tidy profit of 25 %. The investors have put another 15 cents of fix up costs into each house. So the grand total cost of that house to the second set of investors is at least 68 cents.

In order to make the house sell quickly, these investors will discount it from $1 to 90 cents . Also, they will list it with a realtor, who will require a 6% commission. That means the investors will realize a total of 85 cents on each property. They will earn a profit of approximately 26% (17 cents on an investment of 65 cents).

For those who are wondering if foreclosures are a good investment, the answer is yes: provided you know what you’re doing. You can buy on the courthouse steps and resell to those who rehab. If you do your own contracting, and you’re able to attend auctions on the courthouse steps, you can eliminate the middleman. Obviously the profit is potential is far greater this way.

Finally, be aware of market values in your area. Before you purchase a property, make sure you know the extent of repair that it will require, and try to make certain of what the property will be worth after it is completed. That way you will know whether it is worth purchasing the foreclosure at the outset.

Written by Marc Jablon, Realty Associates / 561 / 213 – 6139
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